A guest post by Benjamin Cole
One of the bromides of modern macroeconomics is that “long-term, money is neutral.”
The above maxim makes sense on some levels. A nation is made rich or poor by its investment in infrastructure, education, farmland, factories, work ethics and the like. Running printing presses, per se, is meaningless.
But in the practical world, with wage and price stickiness and institutional rigidities, a central bank can asphyxiate an economy for decades—long enough to be the “long-run” for anybody with a money-earning life of perhaps 50 years.
Case in point is Japan, wherein the Bank of Japan effectively targeted zero inflation for the 20 years after 1992, and just as effectively suffocated growth.
The BoJ’s targeting of zero inflation, or even minor deflation, never worked, and once-soaring Japan fell further behind the United States, in terms of per capita incomes. Meanwhile, Japanese property and equity markets cratered, losing 80 percent of early 1990s values, before recent recoveries. Tight money and minor deflation proved a bottomless debacle.
If a sociopath formed a money-worshipping ascetic cult and gained control of the FOMC (I mean, even worse than now), with the plan to cut the money supply by 66 percent in the next 33 years, would the impact be “neutral”?
History suggests the sadistic FOMC cult’s monetary anorexia could stifle real growth for that full 33 years and more, based on what happened in Japan.
Moreover, Japan today has a smaller economy than it would have had it tried monetary expansion. Even under Abenomics, Japan has decades of lost growth to try to recover.
In brief, money is not long-term neutral. A too-tight money supply can cripple a major, advanced economy for decades on end.
Which leads us to the always-fascinating Center for Financial Stability’s “Divisia” measure of the U.S. money supply, an indicator now sounding the klaxons— Divisia shows money growth nearly dead in the water.
“Divisia M4, including Treasuries—the broadest and most important measure of money calculated by the CFS—grew by 1.6 percent in April 2014, on a year-over-year basis. In contrast, CFS Divisia M4 increased by 5.1 percent in April 2013 over the preceding year,” reported CFS on May 21.
The CFS’s key measure of “money” is very broad, and includes negotiable money-market securities, such as commercial paper, negotiable CDs, and T-bills. The components of Divisia money are similar to the Fed’s old “L” money series, but modernized to be consistent with current market realities, states the CFS.
I will leave it to others to decide what is the best measure of money supply, and even so there would follow inevitable arguments about velocity.
But given the increasing flexibility of financial assets—one can sell a bond and spend the money all in an hour—the argument that broader measures of money are better rings true.
The CFS’s measure of money appears to track real economic output fairly well.
The sad part: I don’t think anybody is surprised that the FOMC and the Fed are putting a lid on the money supply, even as the U.S. economy grinds below capacity and inflation is microscopic.
One need only to read FOMC minutes or listen to a speech or two to divine that the FOMC is fixated on inflation, and many Fedsters rhapsodize about deflation.
Maybe the idea of a cabal of monetary anorexics at the FOMC is not fiction.